"The reinsurance relationship depends on the reinsurer and the
reinsured observing high levels of good faith[,]" id., and thus their
relationship is "often characterized as one of `utmost good faith.'"
Unigard, 4 F.3d at 1054; see also Northwestern Mut. Fire Ass'n. v. Union
Mut. Fire Ins. Co., 144 F.2d 274, 276 (9th Cir. 1944). For example, under
a "follow the fortunes" clause typically found in a reinsurance
contract, "[a] reinsurer cannot second guess the good faith liability
determinations made by its reinsured. . . . Christiania Gen. Ins. Corp.
v. Great American Ins. Co., 979 F.2d 268, 280 (2nd Cir. 1992). At the
same time, however, the reinsurer has the right to question whether the
ceding insurer's claims stem from reinsured losses, and therefore the
reinsurer must have the cooperation of the ceding insurer. See Unigard, 4
F.3d at 1054, 1069; CIGNA, 52 F.3d at 1199-1200; cf. Cal.Ins.Code §
622.*fn1 It is this proposition that has spawned this messy, protracted
litigation between a reinsurer, Stonewall Insurance Company, and a
ceding
insurer, Argonaut Insurance Company. A summary follows.

Argonaut had issued Hughes two primary insurance policies during this
time period. One policy covered the period January 1, 1970 to January 1,
1971, and did not contain a pollution exclusion. This policy was
reinsured by various syndicates of Lloyds of London and included a unique
provision that gave Lloyds full and complete control of any claim asserted
under the primary policy. The other Argonaut policy, most relevant here,
covered Hughes for the period January 1, 1972 through April 1, 1975 for
$1 million per occurrence, and contained a pollution exclusion, which
excluded pollution coverage unless the pollution was "sudden and
accidental." (See Compl., Ex. A.) This policy was reinsured by Stonewall
via three facultative certificates of insurance.*fn3 (See Compl., Exs.
B, C, and D.)

The first of the Hughes primary coverage cases to go to trial was
Hughes Aircraft Co. v. Brian E. Beagley.*fn4 On November 14, 1995, a
California jury found in favor of Hughes and against Beagley in a special
verdict on liability. Specifically, the jury found four different
occurrences or sources of environmental contamination (two in 1960 and
two in 1961) at Hughes' Fullerton plant, thereby triggering Beagley's
coverage. The jury also found that Beagley acted in bad faith for its
wrongful refusal to defend Hughes.

Stonewall, however, balked at submitting the reinsurance monies to
Argonaut. Stonewall questioned Argonaut's candidness about the details of
the Fullerton settlement and was allegedly unable to discern or
meaningfully review the information and mass of documents that Argonaut
had submitted. Stonewall contended that Argonaut had violated a provision
of the reinsurance contract which required that Argonaut cede its
reinsurance claim based on its reasonable, legitimate settlement with the
underlying insured — Hughes.*fn6 That is, Stonewall asserted that
Argonaut settled with Hughes on the basis of multiple pollution
occurrences at the Fullerton plant, a la Beagley, but then turned around
and ceded its reinsurance claim to Stonewall on the basis of one
occurrence. Stonewall also maintained that Argonaut mishandled and
manipulated its Hughes litigation and eventual settlement for several
reasons: (1) to trigger Stonewall's "sudden and accidental" reinsurance
obligation by sidestepping the policy's pollution exclusion for multiple
occurrences; (2) to avoid a finding of bad faith and the resulting
punitive damages that it would not be able to cede to Stonewall; (3) to
avoid the expense of a costly defense to the Hughes coverage; and (4) to
avoid full exposure from the 1970 policy. According to Stonewall,

Argonaut's claimed settlement of a complex
environmental pollution claim, purportedly on a
`one-occurrence' basis, is inconsistent with the
existing facts and law governing its settlement at
that time. The evidence of how and why Argonaut
settled is overwhelming: Argonaut settled [with
Hughes] on the basis of exposure to six occurrences
for liability for substantial bad faith damages for
Argonaut's wilful refusal to defend, knowingly in
contradiction of law and contract. The reason Argonaut
manipulated the settlement from the six occurrences
and bad faith basis is because of the adverse
financial consequences inherent in ceding to its
reinsurers, including Stonewall, in accordance with
the actual settlement.

In its objections, Stonewall argues that, because its motion for
summary judgment asserted the legally, as opposed to factually,
dispositive issue of collateral estoppel, the Magistrate Court erred in
deeming it moot. In other words, Stonewall contends that because its
motion involved a purely legal question, the general rule that a trial
moots a motion for summary judgment, see Watson v. Amedco Steel, Inc.,
29 F.3d 274, 277-78 (7th Cir. 1994), does not apply. Stonewall argues a
ruling on its motion was critical because, if granted, "the Beagley
jury's finding of multiple occurrences would have collaterally estopped
Argonaut from relitigating the number of occurrences had it tried its own
coverage case and therefore, Argonaut could not possibly have settled on
the basis of one occurrence." (Objs. at 2.) In short, Stonewall asks the
court to reserve entering judgment on the jury's verdict until its
assertion of collateral estoppel is addressed.

In response, Argonaut maintains that "Stonewall expressly submitted the
collateral estoppel issue to the jury, instructing the jury at length as
to all of its, elements." (Resp. at 2.) Argonaut then excerpts those jury
instructions in its response, which do indeed ask the jury to resolve the
collateral estoppel issue:

The jury in Beagley found four different occurrences
or sources of environmental contamination at the site
in Fullerton, California under California law,
resulting occurrences for which the insurer was
obligated to indemnify Hughes. You need not reconsider
the jury finding of multiple recurrence [sic]
occurrences in the Beagley trial.

Stonewall also contends that the cessation of
settlement was unreasonable because Argonaut
considered that the effect of the Beagley verdict,
about which you have just heard, would, in all
probability, result in a verdict against Argonaut for
multiple occurrences on the Fullerton claim.

Stonewall bases its argument on a doctrine called
collateral estoppel. The doctrine of collateral
estoppel means that when an issue of ultimate fact has
been previously determined by valid and final
judgment, that issue cannot be relitigated between the
same parties or parties closely related. A jury
verdict is a final judgment.

The doctrine of collateral estoppel requires four
elements: (1) the issue is identical to an issue in a
prior action; (2) the issue was actually litigated in
the prior action; (3) the issue was essential to the
prior judgment; and (4) the party being precluded was
represented in the prior action.

Because the Beagley case involved the same plaintiff
and the identical issue of coverage, number of
occurrences, on the same policy language in the same
court as the suit against Argonaut and because it
ended in, a jury verdict, it is undisputed that the
first two factors are satisfied.

Under the third [sic] factor, privity refers to a
relationship between the party to be estopped and the
unsuccessful party in the prior litigation which is
sufficiently close so as to justify applying
collateral estoppel. Privity exists where the
non-party has an identity of interest with and an
adequate representation by the party in the first
action, and the nonparty should reasonably expect to
be bound by the prior adjudication.

If you find that Argonaut's interests were essentially
identical to those of the Beagley defendants, that
there was an adequate defense in the Beagley
litigation, or that Argonaut should have expected to
be bound by the prior litigation, then you must find
that Argonaut was bound by the ruling in Beagley to
settle, on the basis of multiple occurrences and a
settlement and cession on the basis of one occurrence
was not reasonable.

In such a case, you must find in favor of Stonewall.

(Tr. Trans. 2646-2648.) Thus, Argonaut argues that "[h]aving submitted
the issue to the jury, and having the jury find against Stonewall,
Stonewall cannot now submit the identical issue to another factfinder for
a second bite at the apple. Stonewall has waived, or itself estopped to
claim, any right to summary judgment on the issue." (Resp. at 3.)

Furthermore, Argonaut notes that because the jury found in its favor on
its claims of breach of duty of good faith and breach of duty of utmost
good faith, it necessarily implies that Stonewall had no proper basis,
such as collateral estoppel, for not paying reinsurance reimbursement.
Put another way, Argonaut asserts that the jury's verdict "required [it]
to reject all of Stonewall's defenses, including the argument that
Argonaut was collaterally estopped to claim one occurrence or to deny
that there were six occurrences." (Resp. at 4.) Finally, Argonaut argues
that in any event, Stonewall's assertion, of collateral estoppel is
baseless because (1) the Beagley verdict was not a final judgment
triggering collateral estoppel; (2) the interests of Argonaut and the
Beagley insurers were not identical; (3) whether collateral estoppel
actually applied was irrelevant, what mattered was that the Argonaut
decision-makers considered it; and (4) the jury specifically found that
there was no significance to any collateral estoppel considerations when
the final demand from Hughes was based on only two occurrences.

In reply, Stonewall steadfastly maintains that collateral estoppel is a
legal issue that a jury is not allowed to decide. (See Reply at 1.)
Stonewall notes that this court remarked at a sidebar:

(Trial Tr. at 1740-41.) Further, Stonewall refers to the court's
statement, when referring to the collateral estoppel argument, that "the
jury should not be in a position where it is deciding the applicability
of those concepts of law, and as those concepts may be determined under
California law." (Id.) Moreover, Stonewall claims that the only reason it
submitted the collateral estoppel issue to the jury was "to preserve this
issue, since the Court had not yet ruled on summary judgment motions."
(Id., n. 2.) Finally, Stonewall again asserts that collateral estoppel
does indeed apply.

In this case, it is undisputed that the principles of collateral
estoppel under California law control. See McNealy v. Caterpillar,
139 F.3d 1113, 1116 (7th Cir. 1998) ("Whether a judgment of a state court
results in issue' preclusion depends upon the law of that state.").
Nonetheless, the doctrine of collateral estoppel under California law is
generally consistent with law of the Seventh Circuit. Thus, while
primarily relying on California law to determine whether collateral
estoppel applies, the court also turns to case's from this circuit for
general guidance.*fn9

"Collateral estoppel, like the related doctrine of res judicata, has
the dual purpose of protecting litigants from the burden of relitigating
an identical issue with the same party or his privy and of promoting
judicial economy by preventing needless litigation." Parklane Hosiery
Co. v. Shore, 439 U.S. 322, 326, 99 S.Ct. 645, 58 L.Ed.2d 552 (1979).
Likewise, under California law, collateral estoppel bars relitigation of
factual issues necessarily decided in prior litigation. See Lucido v.
Superior Ct., 51 Cal.3d 335, 272 Cal.Rptr. 767, 769, 795 P.2d 1223
(1990). There are five requirements before collateral estoppel can be
applied under California law: (1) the issue decided previously must be
identical to the issue for which preclusion is sought; (2) the issue must
actually have been litigated in the first proceeding; (3) a decision on
the, issue must have been necessary in the first proceeding; (4) the
prior decision must have been final and on the merits; and (5) the party
sought to be precluded from relitigating the issue must be the same, or
in privity with, the party in the first proceeding. See id. The party
asserting collateral estoppel has the burden of showing that these
requirements are satisfied. See id.

"It is a principle of general application in Anglo-American
jurisprudence that one is not bound by a judgment in personam in a
litigation in which he is not designated as a party or to which he is not
been made a party by service of process." Hansberry v. Lee, 311 U.S. 32,
40, 61 S.Ct. 115, 85 L.Ed. 22 (1940); see also Martin v. Wilks,
490 U.S. 755, 761-62, 109 S.Ct. 2180, 104 L.Ed.2d 835 (1989).
Furthermore, there is a "`deep-rooted historic tradition that everyone
should have his own day in court.'" Martin, 490 U.S. at 762, 109 S.Ct.
2180 (quoting 18 C. Wright, A. Miller, & E. Cooper, Federal Practice and
Procedure § 4449, p. 417 (1981)). "A judgment or decree among parties
to a lawsuit resolves issues among them, but it does not conclude the
rights of strangers to those proceedings." Id.

However, a person in a later suit may be bound by an earlier proceeding
where the person, although not a party to the earlier suit, "has his
interests adequately represented by someone with the same interests who
is a party." Id. n. 2. In other words, a person in privity with the
earlier litigant or whose interests were "virtually represented" by the
earlier litigant is bound by the earlier proceedings. See generally Tice
v. American Airlines, 162 F.3d 966, 971-73 (7th Cir. 1998). The
underlying consideration is whether binding the absentee party violates
due process. See Parklane Hosiery Co., 439 U.S. at 327 n. 7, 99 S.Ct.
645; Tice, 162 F.3d at 971, 973; Kraushaar v. Flanigan, 45 F.3d 1040,
1050 (7th Cir. 1995). "[T]he privity label simply expresses a conclusion
that preclusion is proper." In Matter of L & S Industries, Inc.,
989 F.2d 929, 933 (7th Cir. 1993).

California law is the same: "Privity exists where the nonparty has an
identity of interest with, and adequate representation by, the party in
the first action and the nonparty should reasonably expect to be bound by
the prior adjudication." Helfand v. Nat'l Union Fire Ins. Co.,
10 Cal.App.4th 869, 13 Cal.Rptr.2d 295, 314 (1992)*fn11 Moreover,
California law recognizes the doctrine of virtual representation, which
is "the broadest theory of nonparty preclusion." Id. The doctrine
provides that "a person not a party to prior action nonetheless is bound
if his or her interests are so similar to a party's interest that the
latter was the former's virtual representative in the earlier action."
Id. "In the final analysis, the determination of privity depends upon the
fairness of binding [the party] with the result obtained in earlier
proceedings in which it did not participate." Citizens for Open Access to
Sand and Tide, Inc. v. Seadrift Assoc., 60 Cal.App.4th 1053,
71 Cal.Rptr.2d 77, 88 (1998); see also Vandenberg v. Superior Ct.,
21 Cal.4th 815, 88 Cal.Rptr.2d 366, 375, 982 P.2d 229 (1999);
Sutton v. Golden Gate Bridge, Highway and Transp. Dist.,
68 Cal.App.4th 1149, 81 CaLRptr.2d 155, 158 (1998).

First, the court rejects Stonewall's assertion that "Argonaut . . .
formally intervened in the Beagley litigation." (Mem. at 15.) Stonewall
fails to show, and there is no indication, that Argonaut did so. Indeed,
Argonaut denies that it formally intervened and characterizes Stonewall's
assertion as a "false" statement. (Resp. at 5.)

Stonewall's primary argument, however, is that the doctrine of virtual
representation applies here. Stonewall argues that

[f]or all intents and purposes, the London insurers in
Beagley were the same as Argonaut: the Beagley trial
involved the same claim at issue, the same evidence
was being used to prove the facts of the occurrences,
the same occurrence policy language was at issue, the
litigation was before the same judge before the same
court applying the same law in connection with the
same policyholder, Hughes.

(Mot. at 14.) Stonewall also contends that Argonaut had notice of the
Beagley trial and an opportunity to defend. Stonewall's argument is
without merit.

What Stonewall ignores is that there is no indication that Argonaut
actually participated in the Beagley litigation or that it exercised any
control or advocacy in the case. See Helfand v. National Union Fire Ins.
Co., 10 Cal.App.4th 869, 13 Cal.Rptr.2d 295, 315 (1993) (rejecting
"extreme proposition that a nonparty can be bound by a judgment in an
earlier proceeding of which he or she did not have notice and
notwithstanding that there was virtually no advocacy, no control, and no
actual participation in the litigation by the party with `identical'
interests."); see also National Union Fire Ins. Co. v. Lynette,
27 Cal.App.4th 1434, 33 Cal.Rptr.2d 496, 507 (1994) (party collaterally
estopped from relitigating issue where it had substantially participated
in prior proceeding); Tice, 162 F.3d at 972 (for doctrine of virtual
representation to apply, there must be a showing that "the second party
had participated or had a legal duty to participate."). That Argonaut had
notice of the case and that it sent a representative to closely monitor,
and even attend, the Beagley trial does not suffice. See Richards, 517
U.S. at 800 n. 5, 116 S.Ct. 1761 (stating that mere notice may not
suffice and that the law does not impose a burden to intervene as a
"stranger" when one is absolutely entitled to a hearing). Obviously,
Argonaut had a substantial interest in the Beagley trial. But that
substantial interest, standing alone, is insufficient to support a
finding of privity. See In re Yellow Cab Co., 212 B.R. 154, 158
(Bankr.S.D.Cal. 1997) ("[Privity] requires more than a showing of
parallel interests — it is not enough that the non-party may be
interested in the same questions or proving the same facts.").

Further, Stonewall fails to explain how Argonaut had an opportunity to
defend or appeal the Beagley action. "[A]n unreviewable decision can
provide no basis for later imposing on nonparties the preclusive effects
of res judicata or collateral estoppel as to issues not fully litigated
in any meaningful sense." Pacific Estates, Inc. v. Superior Ct.,
13 Cal.App.4th 1561, 17 Cal.Rptr.2d 434, 443 (1993) (citing Restatement
2d Judgments, § 28(1), com.(a)); see also Vanderberg, 88 Cal.Rptr.2d
at 375, 982 P.2d 229 (collateral estoppel inapplicable where there is no
opportunity for judicial review of adverse rulings). While Beagley's
representatives settled soon after the jury's verdict, Argonaut's counsel
may have continued to defend, and to challenge the jury's verdict,
throughout the appellate process. Beagley's representation was therefore
not adequate; that Argonaut also eventually settled with Hughes does not
alter the court's conclusion. In short, despite the Beagley jury's
verdict, Argonaut was still entitled to its day in court to be heard and
to fully litigate the Hughes coverage issue. Therefore, it would be
unfair and in violation of due
process to bind Argonaut to the Beagley jury's verdict.

At the outset, the court notes that neither its research nor the
parties' has found any "authoritative" California decision addressing
whether that state's law authorizes a reinsured to recover tort damages
for its reinsurer's breach of duty of good faith.*fn13 The court says
"authoritative" because one California appellate court decision (cited by
Stonewall) has spoken on the issue and answered the query in the
negative, but the California Supreme Court later ordered the opinion
"de-published." See Central Nat'l Ins. Co. v. Prudential Reinsurance
Co., 241 Cal.Rptr. 773 (Cal. Ct.App. 1987), review denied and ordered not
to be officially published (Cal. Feb. 4, 1988). Where the California
Supreme Court orders an opinion "de-published," see California Rules of
Court, Rule 979, a court or a party cannot cite or rely on that opinion,
see id., Rule 977, This practice, however, has been subject to
criticism. See Vu v. Prudential Property & Cas. Ins. Co., 172 F.3d 725,
725 (9th Cir. 1999) (noting that the "precedential effect of a
depublication order is not entirely clear" and citing articles
criticizing the practice); cf. In re Memorial Hosp. of Iowa County,
Inc., 862 F.2d 1299, 1302 (7th Cir. 1988) ("When a clash between genuine
adversaries produces a precedent, however, the judicial system ought not
allow the social value of that precedent, created at cost to the public
and other litigants, to be a bargaining chip in the process of
settlement."). Moreover, a de-publication order "shall not be deemed an
expression of an opinion of the [California] Supreme Court of the
correctness of the result reached by the decision or any of the law set
forth in the opinion." California Rules of Court, Rule 979(e).
Furthermore, "the analysis in an unpublished opinion may properly be
considered." People v. MeDaniels, 21 Cal.App.4th 1560, 27 Cal.Rptr.2d 245,
248 n. 2 (1994).

Given that the court has little "authoritative" guidance from the
California courts, it would be far more preferable to certify the issue
to the California Supreme Court. See California Rules of Court, Rule
29.5. However, this court, as a federal district court, does not have
that luxury.*fn14 Rule 29.5(a); see also California Teachers Assoc. v.
Davis, 64 F. Supp.2d 945, 951 n. 3 (C.D.Cal. 1999); compare ILCS S.Ct.
Rule 20. Hence, it remains incumbent upon the court to predict how the
California Supreme Court would decide the issue.

Although the California Supreme Court has yet to decide whether
California law authorizes a reinsured to recover tort damages for its
reinsurer's breach of duty of good faith, the high court's pronouncements
in opinions addressing the availability of tort recovery in breach of
contract cases suggests that it would answer that query in the negative.
See Erlich v. Menezes, 21 Cal.4th 543, 87 Cal.Rptr.2d 886, 890-93,
981 P.2d 978 (1999) (expressing skepticism on the recovery of tort
damages in breach of contract cases); Cates Construction, Inc. v. Talbot
Partners, 21 Cal.4th 28, 86 Cal.Rptr.2d 855, 864-78, 980 P.2d 407
(same, and holding that tort recovery was unavailable for a breach of the
implied covenant of good faith in the context of a construction
performance bond despite surety bond's similarities to insurance); Freeman
& Mills, Inc. v. Beleher Oil Co., 11 Cal.4th 85, 44 Cal.Rptr.2d 420,
425-31, 900 P.2d 669 (1995) (overruling a 1984 California Supreme Court
decision that had recognized a tort cause of action based on the
defendant's bad faith denial of the existence of a non-insurance
contract); Foley v. Interactive Data Corp., 47 Cal.3d 654, 254 CaLRptr.
211, 227-240, 765 P.2d 373 (providing extensive discussion before holding
that tort damages are not recoverable for breach of the implied covenant
of good faith in an employment contract). In each of these cases,
California law is clear: tort damages are generally not available for a
breach of contract. The California Supreme Court has identified the
reasons for denying tort recovery in breach of contract cases: (1) the
different objectives underlying tort and contract breach; (2) the
importance of predictability in assuring commercial stability in
contractual dealings; (3) the potential for converting every contract
breach into a tort, with accompanying punitive damage recovery; (4) and
the preference for legislation in affording appropriate remedies. See
Erlich, 87 Cal.Rptr.2d at 892, 981 P.2d 978. Further, the court has noted
that "[r]estrictions on contract remedies serve to protect the freedom to
bargain over special risks and to promote contract formation by limiting
liability to the value of the promise." Id. at 893, 981 P.2d 978
(citations and internal quotation marks omitted).

However, the California Supreme Court has recognized limited exceptions
to the general rule that tort damages are not recoverable for breach of
contract. The limited exceptions are where "the duty that gives rise to
tort liability is either completely independent of the contract or arises
from conduct which is both intentional and intended to harm." Erlich, 87
Cal.Rptr.2d at 891, 981 P.2d 978. The most notable exception,
well-established under California law, is that tort damages are available
to an insured where the insurer breaches the implied covenant of good
faith and fair dealing in an insurance contract. See id; Cates, 80
Cal.Rptr.2d at 865, 980 P.2d 407; Foley, 254 Cal.Rptr. at 227-28,
765 P.2d 373. The answer in the instant case would thus seem clear:
Argonaut is entitled to recover tort damages for Stonewall's breach of
the duty of good faith. But the court's inquiry does not end here.

The California Supreme Court has noted that the insurance contract
exception (i.e., recognizing that a breach of the implied covenant of
good faith and fair dealing provides a basis for recovery in tort) "is a
major departure from traditional principles of contract law." See Cates,
86 Cal.Rptr.2d at 867, 980 P.2d 407 (quotation marks and citations
omitted); see also Foley, 254 Cal.Rptr. at 232, 765 P.2d 373.
Traditionally, "[b]ecause the covenant of good faith and fair dealing is
essentially a contract term that aims to effectuate the contractual
intentions of the parties, 'compensation for its breach has almost always
been limited to contract rather than tort remedies.'" Id. at 865,
980 P.2d 407 (quoting Foley, 254 Cal.Rptr. at 227, 765 P.2d 373). Thus,
the compensation for the breach of contract traditionally reflects a
limited amount predictable at the time the parties entered into the
agreement. Erlich. 87 Cal.Rptr.2d at 890, 981 P.2d 978; see also
Cal.Civ.Code §§ 3300, 3301. As alluded to earlier, "[t]his limitation
on available damages serves to encourage contractual relations and
commercial activity by enabling parties to estimate in advance the
financial risks of their enterprise." Erlich, 87 Cal.Rptr.2d at 890,
981 P.2d 978.

Unlike most other contracts for goods and services, an
insurance policy is characterized by elements of
adhesion, public interest and fiduciary
responsibility. [Citations] In general, insurance
policies are not purchased for profit or advantage;
rather they are obtained for peace of mind and
security in the event of an accident or other
catastrophe. [Citation] Moreover, an insured faces a
unique "economic dilemma" when its insurer breaches
the implied covenant of good faith and fair dealing.
[Citation] Unlike other parties in contract who
typically may seek recourse in the marketplace in the
event of a breach, an insured will not be able to find
another insurance company willing to pay for a loss
already incurred. In addition the tort duty of a
liability insurer ordinarily is based on the
assumption of the insured's defense and of settlement
negotiations of third party claims.

86 Cal.Rptr.2d at 865, 980 P.2d 407; see also Erlich, 87 Cal.Rptr.2d at
892, 981 P.2d 978; Foley, 254 Cal.Rptr. at 232, 765 P.2d 373 (listing
similar factors). The Cates court also specifically referred to the
"unequal bargaining power" between an insurer and an insured. See id. at
871, 980 P.2d 407.

Thus, in the instant case, this court must carefully review these
policy reasons to determine whether the insurance contract exception
extends to the reinsurance context. See Cates, 86 Cal.Rptr.2d at 871,
980 P.2d 407 ("[W]e must evaluate whether the policy considerations
recognized in the common law support the availability of tort remedies in
the context of a performance bond.") Upon review of these policy
reasons, the court concludes that tort damages for breach of the duty of
good faith are not recoverable in the reinsurance context. In other
words, the policy reasons that allow an original insured to recover tort
damages for its insurer's breach of the duty of good faith under
California law do not extend to the reinsurance context to allow a
reinsured to recover tort damages against a reinsurer. Indeed, as one
commentator has noted, "The primary mistake of most courts considering
reinsurance issues is blindly applying principles of original insurance."
Thomas, supra, at 1597; cf. Unigard, 4 F.3d at 1065 ("[C]anons of
construction that protect individual purchasers of original insurance
policies do not apply to reinsurance.").

Finally, the court turns to whether a reinsurer has a "fiduciary
responsibility" in dealing with its reinsured. That the duty of good
faith applies to both the reinsurer and the reinsured would seem to
suggest that a reinsurer does have such a responsibility. The California
Supreme Court has observed that "`[i]nsurers hold themselves out as
fiduciaries. . .'" Egan v. Mutual of Omaha Ins. Co., 24 Cal.3d 809,
169 Cal.Rptr. 691, 696, 620 P.2d 141 (1979) (quoting Goodman & Seaton,
Foreword: Ripe for Decision, Internal Workings and Current Concerns of
the California Supreme Court, 62 Cal.L.Rev. 309, 346-47 (1974)); see also
Gibson v. Gov't Employees Ins. Co., 162 Cal.App.3d 441, 208 Cal.Rptr. 511,
513 (1984). California courts, however, have not spoken on the issue in
the reinsurance context.

In sum, the relevant policy reasons for allowing an original insured to
recover tort damages against its insurer for breaching the covenant of
good faith in an insurance contract do not extend to the reinsurance
context. The California Supreme Court has "cautioned courts to exercise
great care in considering whether to extend the insurance contract
exception to another contract setting." Cates, 86 Cal.Rptr.2d at 866,
980 P.2d 407 (declining to extend exception to breach of implied covenant
of good faith in the context of a surety bond despite its similarities to
insurance); see also Foley, 47 Cal.3d 654, 254 Cal.Rptr. 211, 227-240,
765 P.2d 373 (declining to extend exception to breach of the implied
covenant of good faith in employment contract). Furthermore, the
California Supreme Court has noted that "[c]ourts should be careful to
apply tort remedies only when the conduct in question is so clear in
deviation from socially useful business practices that the effect of
enforcing such tort duties will he to aid rather than discourage
commerce," Erlich, 87 Cal.Rptr.2d at 893, 981 P.2d 978 (citation and
interna quotation marks omitted).

For these reasons, and in the absence of any California court decision
addressing the insurance contract exception in the reinsurance context,
this court finds that extending the exception here would be contrary to
California law. Under California law, a reinsured cannot recover tort
damages for its reinsurer's breach of the covenant of good faith in a
reinsurance contract. Moreover, California law prohibits an award of
punitive damages for breach of contract. See Cal.Civ.Code § 3294.
Accordingly, the court strikes the jury's $13 million punitive damages
award to Argonaut against Stonewall.

Whether the Court May Decide Stonewall's Declaratory Judgment Count

Stonewall asks the court to decide its declaratory judgment count,
claiming that it is still a live issue. Stonewall's declaratory judgment
count asked the court to declare (1) that Stonewall was entitled to "all
information necessary" to evaluate the propriety of the Fullerton
Settlement and the basis for Argonaut's coverage and request for
indemnification; and (2) that Stonewall was not obligated to reimburse
Argonaut unless such information was given. Stonewall did not request a
jury.

Argonaut asks the court to award it prejudgment interest at 7% on its
breach of contract award. Argonaut asserts that prejudgment interest
should be calculated on $2,408,769.24 from April 10, 1996 (the date it
billed Stonewall) to October 16, 1996 and on $2,455,986.35 from October
16, 1996 to the date of this judgment. Argonaut's 7% rate of interest is
based on California law. Stonewall, on the other hand, contends that
Illinois' 5% rate of interest should apply. Further, Stonewall argues
that prejudgment interest should be awarded only from the date this
action was filed — May 31, 1996.

First, the court addresses Stonewall's contention that Illinois' 5%
rate of interest should apply. Here, the parties did not include an
express choice of law provision in their reinsurance policies. Thus, this
court, as "[a] district court exercising jurisdiction because of the
diversity of citizenship of the parties[,] must apply the choice of law
rules of the state in which it sits." Curean v. Kwon, 153 F.3d 481, 488
(7th Cir. 1998). Accordingly, this court must apply Illinois' choice of
law rules governing contracts. See id. Illinois' approach is to select
the jurisdiction with the most significant contacts with the transaction
and the parties. See id. The court must therefore consider "the place of
contracting, the place of negotiation of the contract, the place of
performance, the location of the subject matter of the contract and the
domicile and nationality of the parties." Id.; see also Lapham-Hickey
Steel Corp. v. Protection Mut. Ins. Co., 166 Ill.2d 520, 211 Ill.Dec.
459, 655 N.E.2d 842, 845 (1995)*fn18

The court (1) sustains Stonewall's objections to the Magistrate Court's
Report recommending that Stonewall's motion for summary judgment be
denied as moot; (2) denies Stonewall's motion for summary judgment
because collateral estoppel would not have barred Argonaut from
litigating the issue of number of occurrences after the conclusion of the
Beagley litigation; (3) strikes the jury's $13 million award of punitive
damages to Argonaut because under California law tort damages are not
recoverable for breach of the covenant of good faith in the reinsurance
context; (4) dismisses as moot Stonewall's declaratory judgment count;
and (5) finds that California's 7% interest rate on prejudgment interest
applies from May 31, 1996. Argonaut shall submit a judgment order
consistent with this opinion by December 15, 1999.

IT IS SO ORDERED.

Our website includes the main text of the court's opinion but does not include the
docket number, case citation or footnotes. Upon purchase, docket numbers and/or
citations allow you to research a case further or to use a case in a legal proceeding.
Footnotes (if any) include details of the court's decision.

Buy This Entire Record For
$7.95

Official citation and/or docket number and footnotes (if any) for this case available with purchase.